A fundamental aspect of the lending process is the ability of lenders to quantify and evaluate the financial strengths and/or weaknesses of potential and current borrowers. Such assessments underlie not only initial decisions about loan applications, but also ongoing evaluations of a borrower's repayment capacity after the initial loan decision. Understanding changes in the financial position of individual borrowers can help lenders address potential problems for individual borrowers, as well as help lenders understand the aggregate risk characteristics associated with entire loan portfolios.
Since the advent of the 2007-2008 financial crisis, government regulators have intensified their scrutiny of lenders' credit risk management practices. In particular, regulators have been increasingly requiring lenders to quantify risks and assess the impact of changing market conditions on the risks in their loan portfolios, ultimately with the goal of determining potential effects on the lender's financial standing, including the lender's capital, loan and lease loss reserves, and earnings. As just one example, bank examiners are often asking lenders to more actively manage their loan portfolios, including stress testing loans to determine the sensitivity of portfolio segments with common risk characteristics to potential market conditions.
The financial crisis has also led to decreases in the overall number of loans over the last four years for most complex credit areas. In addition, between 2007 and 2010, net charge offs to loans more than quadrupled, the number of non-current loans increased to about 5%, return on assets decreased, and the number of FDIC Problem Institutions skyrocketed to about 12% of FDIC insured banks. The current lending environment makes it more important than ever for lenders to actively and accurately manage their existing loan portfolios. Active portfolio management can provide insight enabling a lender to maximize returns on smaller portfolios, more accurately predict troublesome loans, and take proactive steps to mitigate those risks.
Unfortunately, understanding the risks inherent in each loan or in a group of loans in a lender's portfolio can be a challenging undertaking Loan portfolios may include many types of loans to many different kinds of borrowers. For example, a single loan portfolio may include multiple loans for commercial real estate, construction, commercial industrial, small business, agriculture, and consumer purposes. Each borrower's financial position can vary based on a multitude of different factors and each type of loan may be subjected to different types and/or degrees of changing market conditions. In addition, it can be important to understand and be able to comprehensively evaluate loans across multiple cross-sections of a portfolio, including for example, for the entire portfolio, a portfolio segment, individual loans, and loans by branch, loan officer, customer, business type, credit relationships, risk rating, and/or scoring date.